Why the US Dollar Is the Global Currency: A Guide to Know

Introduction

The use of a universal currency facilitates trade across countries. Most financial dealings between countries use a mix of different currencies. U.S. dollars, Euros, and Japanese yen are the most frequently used. The term "reserve currency" is often used to refer to a worldwide currency. The U.S. dollar is widely accepted, as reported by the International Monetary Fund. As of the end of the fourth quarter of 2019, it accounts for more than 60% of all the foreign exchange reserves held by the world's central banks. It highlighted the problems associated with a monetary union whose guidance is provided by several political bodies.

Understanding Global Currencies and Gold

Once upon a time, gold was the basis for every currency, and each nation was required to keep a stockpile of gold equal to its currency value. This means that all coins were valued relative to gold. After WWII, the United States economy surpassed all others as the world's primary economic power. Bank reserves did not have sufficient gold reserves to back the currency increase, which was required to finance the worldwide boom following the war. The United States abandoned the gold standard and increased its paper currency printing to meet the needs of a rapidly expanding global economy. Given the strength of the American economy, other nations abandoned the gold standard and began accepting the dollar as legal cash. As a result, the dollar rose to become the world's reserve currency.

Why the Dollar Is the Global Currency

The dollar's rise to prominence began with the Bretton Woods Accord in 1944. Before that time, the majority of nations used the gold standard. Upon request, the governments of these nations said they would exchange their currencies for gold at face value. At a meeting in Bretton Woods, New Hampshire, the world's industrialized countries agreed to set their currencies' values about the dollar. The United States had the world's most significant gold reserves. By reaching this arrangement, other countries may use the U.S. dollar as a reserve currency rather than gold. In the early 1970s, certain nations started insisting on gold in exchange for dollars. To fight inflation, they would have to take these measures. President Nixon decoupled the currency from gold rather than see Fort Knox depleted of its reserves.

The U.S. Dollar Is the Strongest World Currency. The relatively strong U.S. economy supports the dollar's value. As a result, the dollar has become the most influential currency in the world. There was $2.04 trillion in U.S. currency in circulation as of 2020. Half or more of that amount may be in use in other countries. 2 These bills are prevalent in several countries across Latin America and the countries that once comprised the Soviet Union. They are widely accepted as legal tender for everyday transactions. The dollar is the de facto standard in the foreign exchange market. The U.S. dollar is involved in about 90 percent of all foreign exchange transactions. There are 185 currencies on the Iso list, but most are only in circulation within their respective countries of origin.

Dollars are used to issue nearly 40% of all debt worldwide. So, foreign banks need a lot of dollars to function. During the economic collapse of 2008, this became clear. Foreign currency international liabilities held by non-American banks totaled $27 trillion. U.S. dollars made up $18 trillion of that total. The Federal Reserve Board of Governors of the United States of America consequently increased the dollar swap line. The world's banks needed to do that, or they'd run out of dollars. Following the financial meltdown, the dollar's already widespread use increased. In 2018, European banks' dollar liabilities exceeded those denominated in the currencies of Germany, France, and the United Kingdom.

Regulations imposed on banks to forestall another financial crisis can also reduce currency availability. That is also a likely result of a Fed funds rate hike. Raising interest rates on loans depletes the money supply. Because of its stability and value, the dollar is widely held by governments as part of their foreign exchange reserves. Governments acquire currency through international trade. They can also be exchanged for domestic cash by domestic businesses and tourists. Foreign currency reserves are a popular investment choice for some governments.

Conclusion

The United States continues to enjoy widespread faith and confidence in its ability to honor its debts, even though its external debts now total trillions of dollars and its budget deficits are persistently large. This is why the U.S. dollar continues to be the most valuable currency in circulation. Perhaps it will maintain its position as the most crucial currency in international trade. However, the dollar's current top spot is not guaranteed. China and Russia are among the countries that believe the time has come for a new global currency that is not tied to any one country. According to some economists, a minor role for the dollar internationally is nothing to be afraid of and could even be good for the United States.